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[February 28, 2014]
QLT INC/BC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Edgar Glimpses Via Acquire Media NewsEdge) The following information should be read in conjunction with the accompanying 2013 consolidated financial statements and notes thereto, which are prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP"). All of the following amounts are expressed in U.S. dollars unless otherwise indicated.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This Report contains forward-looking statements within the meaning of the United States Private Securities Litigation Reform Act of 1995 and "forward looking information" within the meaning of the Canadian securities legislation which are based on our current expectations and projections. Words such as "anticipate," "project," "potential," "goal," "believe," "expect," "forecast," "outlook," "plan," "intend," "estimate," "should," "may," "assume," "continue" and variations of such words or similar expressions are intended to identify our forward-looking statements and forward-looking information. Such statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of QLT to be materially different from the results of operations or plans expressed or implied by such forward-looking statements and forward-looking information. Many such risks, uncertainties and other factors are taken into account as part of our assumptions underlying the forward-looking statements and forward-looking information.
The following factors, among others, including those described under Item 1A.
Risk Factors in Part I of this Report could cause our future results to differ materially from those expressed in the forward-looking statements and forward-looking information: • our expectations regarding the results of our review of strategic alternatives announced in November 2013; • unanticipated negative effects of our strategic restructuring in 2012, including our significant reduction in workforce and disposition of our Visudyne business and PPDS Technology; • our ability to maintain adequate internal controls over financial reporting; • our ability to retain or attract key employees, including a Chief Executive Officer; • the anticipated timing, cost and progress of the development of our technology and clinical trials; • the anticipated timing of regulatory submissions for product candidates; • the anticipated timing for receipt of, and our ability to maintain, regulatory approvals for product candidates; • our ability to successfully develop and commercialize our synthetic retinoid program; • existing governmental laws and regulations and changes in, or the failure to comply with, governmental laws and regulations; • the scope, validity and enforceability of our and third party intellectual property rights; • the anticipated timing for receipt of, and our ability to obtain and maintain, orphan drug designations for our synthetic retinoid; • receipt of all or part of the contingent consideration pursuant to the stock purchase agreement entered into with Tolmar, which is based on anticipated levels of future sales of Eligard; • receipt of the full Laser Earn-Out Payment, which is currently subject to a dispute with Valeant, and receipt of all or part of the other contingent consideration pursuant to the Valeant Agreement, which is based on future sales of Visudyne outside of the United States and sales attributable to any new indications for Visudyne; • receipt of all or part of the contingent consideration pursuant to the asset purchase agreement with Mati based on Mati's successful development and sales of products based on our PPDS Technology; 40 -------------------------------------------------------------------------------- • our ability to effectively market and sell any future products; • changes in estimates of prior years' tax items and results of tax audits by tax authorities; and • unanticipated future operating results.
Although we believe that the assumptions underlying the forward-looking statements and forward-looking information contained herein are reasonable, any of the assumptions could be inaccurate, and therefore such statements and information included in this Annual Report may not prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements and forward-looking information included herein, the inclusion of such statements and information should not be regarded as a representation by us or any other person that the results or conditions described in such statements and information or our objectives and plans will be achieved. Any forward-looking statement and forward-looking information speaks only as of the date on which it is made. Except to fulfill our obligations under the applicable securities laws, we undertake no obligation to update any such statement or information to reflect events or circumstances occurring after the date on which it is made.
Overview Strategic Restructuring QLT is a biotechnology company dedicated to the development and commercialization of innovative ocular products that address the unmet medical needs of patients and clinicians worldwide. On July 9, 2012, as a result of a comprehensive business and portfolio review by our Board of Directors (the "Board"), we announced a new corporate strategy and plans to restructure our operations in order to concentrate our resources on our clinical development programs related to our synthetic retinoid, QLT091001, for the treatment of certain inherited retinal diseases. In connection with the strategic restructuring of the Company, over the course of 2012 and 2013 we completed the sale of our Visudyne® business to Valeant Pharmaceuticals International, Inc.
("Valeant") and the sale of our punctal plug drug delivery system ("PPDS") to Mati Therapeutics Inc. ("Mati"), and, as a result, significantly reduced our workforce by approximately 180 employees. Our remaining employees are focused on the development of QLT091001.
In connection with the restructuring, following the departure of Robert Butchofsky, the Company's former President and Chief Executive Officer, on August 2, 2012, the Board formed an Executive Transition Committee currently composed of Directors Jeffrey Meckler and Dr. John Kozarich to perform the function of the Chief Executive Officer on an interim basis while the Board determines the resources and management necessary to pursue the Company's new strategy. Jeffrey Meckler serves as Chairman of the Executive Transition Committee.
In 2013, the Company met with the U.S. Food and Drug Administration ("FDA") and the European Medicines Agency ("EMA"), including an end-of-phase II meeting with the FDA, with a goal to progress QLT091001 for the treatment of certain inherited retinal diseases into pivotal trials in 2014. We also initiated a Phase IIa trial of QLT091001 for the treatment of impaired dark adaptation (IDA) to investigate the safety and efficacy of the drug in a larger patient population. In parallel with our continued development efforts on QLT091001, in November 2013 we announced that we have commenced a review of strategic alternatives for the Company and have engaged Credit Suisse to act as our financial advisor.
Return of Capital In connection with the strategic restructuring, the following transactions were executed during 2013 to return capital to the Company's shareholders: (a) Cash Distribution On June 27, 2013, we completed a $200.0 million special cash distribution, by way of a reduction of the paid-up capital of the Company's common shares (the "Cash Distribution"). The Cash Distribution was approved by the Company's shareholders at QLT's annual and special shareholders' meeting on June 14, 2013.
All shareholders 41 -------------------------------------------------------------------------------- of record as at June 24, 2013 (the "Record Date") were eligible to participate in the Cash Distribution and received a payment of approximately $3.92 per share based upon the 51,081,878 common shares issued and outstanding on the Record Date.
(b) Share Repurchase Program On October 2, 2012, we commenced a normal course issuer bid to repurchase up to 3,438,683 of our common shares, which represented 10% of our public float as of September 26, 2012. All purchases were effected in the open market through the facilities of the NASDAQ Stock Market in accordance with all applicable regulatory requirements. During the years ended December 31, 2013 and 2012, we repurchased 1,691,479 and 1,747,204 common shares under the terms of this bid at a cost of $13.5 million (average price of $7.97 per common share) and $13.7 million (average price of $7.84 per common share), respectively. The bid was completed on March 12, 2013. We retired all of these shares as they were acquired. In connection with this retirement, we recorded an increase in additional paid-in capital of $2.0 million in 2013 and $2.4 million in 2012.
Sales of Assets and Discontinued Operations Punctal Plug Delivery Program On April 3, 2013, we completed the sale of our punctal plug drug delivery system technology (the "PPDS Technology") to Mati Therapeutics Inc. ("Mati"). Mati is a development company founded by Robert L. Butchofsky, our former President and Chief Executive Officer, whose employment with QLT was terminated on August 2, 2012 as part of the strategic restructuring described above. In July 2012, we retained Goldman Sachs to explore the sale or spin-out of our PPDS Technology and after an assessment of these alternatives; on December 24, 2012 we granted Mati a 90-day exclusive option to acquire the PPDS Technology in exchange for $0.5 million. On April 3, 2013, following Mati's exercise of the option, we entered into an asset purchase agreement with Mati and completed the sale of the PPDS Technology to Mati. Under the terms of our asset purchase agreement with Mati (the "Mati Agreement"), we received an additional payment of approximately $0.8 million at closing and are eligible to receive potential payments upon the satisfaction of certain product development and commercialization milestones that could reach $19.5 million (or exceed that amount if more than two products are commercialized), a low single digit royalty on world-wide net sales of all products using or developed from the PPDS Technology and a fee on payments received by Mati in respect of the PPDS Technology other than net sales. Under the terms of the Mati Agreement, we have not had any significant ongoing involvement in the operations or cash flows related to the PPDS Technology other than minor transition services which we agreed to provide. The activities related to the transition services were complete as at September 30, 2013.
Visudyne® In connection with our strategic restructuring, on September 24, 2012, we completed the sale of our only commercial product, Visudyne, to Valeant Pharmaceuticals International, Inc. ("Valeant"). Pursuant to the asset purchase agreement between the Company and Valeant (the "Valeant Agreement"), we sold all of our assets related to our Visudyne business, including the Qcellus laser then under development by us and certain other photodynamic therapy intellectual property. Upon closing we received a payment of $112.5 million, of which $7.5 million (previously held in escrow) was released to us on September 26, 2013.
These funds were held in escrow for one year following the closing date to satisfy any potential indemnification claims that Valeant may have had. Subject to the achievement of certain future milestones, we are also eligible to receive the following additional consideration: (i) a milestone payment of $5.0 million if receipt of the registration required for commercial sale of the Qcellus laser in the United States (the "Laser Registration") is obtained by December 31, 2013, $2.5 million if the Laser Registration is obtained after December 31, 2013 but before January 1, 2015, and $0 if the Laser Registration is obtained thereafter ("Laser Earn-Out Payment"); (ii) up to $5.0 million in each calendar year commencing January 1, 2013 (up to a maximum of $15.0 million in the aggregate) for annual net royalties exceeding $8.5 million pursuant to the Amended and Restated PDT Product Development, Manufacturing and Distribution Agreement with Novartis Pharma AG ("Novartis"), which we transferred to 42 -------------------------------------------------------------------------------- Valeant in connection with the sale, or from other third-party sales of Visudyne outside of the United States ("U.S."); and (iii) a royalty on net sales attributable to new indications for Visudyne, if any should be approved by the FDA. During 2013, we did not receive any contingent consideration related to annual net royalties payable to Valeant pursuant to the Novartis Agreement in respect of the sale of Visudyne outside of the U.S.
On September 26, 2013, the FDA approved the premarket approval application ("PMA") supplement for the Qcellus laser and we have invoiced Valeant for the $5.0 million Laser Earn-Out Payment. Valeant has disputed payment on the basis that it believes the Laser Earn-Out Payment remains contingent upon receipt of additional governmental authorizations with respect to the Qcellus laser. While we believe that the Laser Earn-Out Payment is currently due and payable by Valeant, the outcome of any dispute is uncertain and we may have difficulty collecting the Laser Earn-Out Payment in full.
As at December 31, 2013, the $4.0 million estimated fair value of the $20.0 million of aggregate potential contingent payments represents the fair value of the $5.0 million Laser Earn-Out Payment net of $1.0 million of potential collection costs to account for the increased uncertainty related to collection risk. The remaining estimated fair value of the contingent consideration, which relates to estimated future net royalties pursuant to the Novartis Agreement, is currently valued at nil.
In connection with the sale of our Visudyne business, we entered into a transition services agreement with Valeant, pursuant to which we have been providing transition services to Valeant concerning most of the aspects of the Visudyne and Qcellus laser business. In the third quarter of 2013, we completed all of our transition services under our transition services agreement with Valeant related to Visudyne, the commercial sale of Visudyne, and obtaining FDA approval of the Qcellus laser through the PMA process.
Eligard On October 1, 2009, we divested the Eligard line of products to TOLMAR Holding, Inc. ("Tolmar") as part of the sale of all of the shares of our U.S. subsidiary, QLT USA, Inc. ("QLT USA"). Pursuant to the stock purchase agreement, we are entitled to future consideration payable quarterly in amounts equal to 80% of the royalties paid under the license agreement with Sanofi Synthelabo Inc.
("Sanofi") for the commercial marketing of Eligard in the U.S. and Canada, and the license agreement with MediGene Aktiengesellschaft ("MediGene"), which, effective March 1, 2011, was assigned to Astellas Pharma Europe Ltd.
("Astellas"), for the commercial marketing of Eligard in Europe. The $36.6 million estimated fair value of the remaining future quarterly payments is reflected as Contingent Consideration on our Consolidated Balance Sheet. We are entitled to these quarterly payments until the earlier of our receipt of $200.0 million or October 1, 2024. As of December 31, 2013, we received an aggregate of $162.0 million of contingent consideration. While we expect to receive the remaining $38.0 million of contingent consideration over the next year, our continued receipt of contingent consideration under the stock purchase agreement is dependent upon sales of Eligard by Sanofi and Astellas, which could vary significantly due to competition, manufacturing difficulties and other factors.
Research and Development We devote significant resources to our research and development programs. See Item 1. Business - Overview - Research and Development.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting periods presented. Significant estimates are used for, but not limited to, the fair value of contingent consideration, allocation of overhead expenses to research and development, stock-based compensation, restructuring costs and provisions for taxes, tax assets and liabilities. Actual results may differ from estimates made by management. The significant accounting policies which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include those which follow: 43-------------------------------------------------------------------------------- Contingent Consideration Our contingent consideration assets relate to former sales of our Visudyne business and QLT USA, Inc. Contingent consideration is measured at fair value and revalued at the end of each reporting period. Fair value changes are reported as part of Investment and Other Income related to continuing operations. The fair value change in contingent consideration is positively impacted by the passage of time, since all remaining expected cash flows are closer to collection, thereby increasing their present value. The fair value change in contingent consideration is also impacted by the projected amount and timing of expected future cash flows as well as the cost of capital used to discount these cash flows.
As at December 31, 2013, the fair value of contingent consideration related to our sale of QLT USA, Inc. was $36.6 million. To estimate the fair value of contingent consideration at December 31, 2013, we used a discounted cash flow model based on estimated timing and amount of future cash flows, discounted using a cost of capital of 9% for the contingent consideration related to the Eligard royalties determined by management after considering available market and industry information. Future cash flows were estimated based on historical sales data, expected competition and current exchange rates. If the discount rate were to increase by 1%, the contingent consideration related to the sale of QLT USA would decrease by $0.2 million, from $36.6 million to $36.4 million. If estimated future sales of Eligard were to decrease by 10%, the contingent consideration related to the sale of QLT USA would decrease by $0.3 million, from $36.6 million to $36.3 million.
As at December 31, 2013, the fair value of contingent consideration related to Laser Earn-Out Payment, which was reclassified to current accounts receivable, is $4.0 million. The $4.0 million estimated fair value represents the $5.0 million face value of the Laser Earn-Out Payment net of $1.0 million of potential collection costs to account for increased uncertainty related to collection risk.
Stock-Based Compensation Accounting Standards Codification ("ASC") topic 718 requires stock-based compensation to be recognized as compensation expense in the statement of earnings based on their fair values on the date of the grant, with the compensation expense recognized over the period in which a grantee is required to provide service in exchange for the stock award. Compensation expense recognition provisions are applicable to new awards and to any awards modified, repurchased or cancelled after the adoption date.
We use the Black-Scholes option pricing model to estimate the value of our stock option awards at each grant date. The Black-Scholes option pricing model was developed for use in estimating the value of such options that have no vesting restrictions and are fully transferable. In addition, option pricing models require the input of highly subjective assumptions including the expected stock price volatility. We project expected volatility and expected life of such options based upon historical and other economic data trended into future years.
The risk-free interest rate assumption is based upon observed interest rates that coincide with the terms of our options.
For the year ended December 31, 2013, stock-based compensation expense of $0.6 million was expensed as follows: $0.4 million to research and development costs, $0.2 million to selling, general and administrative costs, and nil to discontinued operations. The weighted average assumptions used to value the options granted during 2013 included: volatility of 46.0%, a 6.5 year expected life, and a 2.0% risk-free interest rate.
For the year ended December 31, 2012, stock-based compensation expense of $5.8 million was expensed as follows: $1.5 million to research and development costs, $1.8 million to selling, general and administrative costs, and $2.4 million to discontinued operations. The weighted average assumptions used to value options granted during 2012 included: volatility of 46.8%, a 3.8 year expected life, and a 1.0% risk-free interest rate.
Research and Development Research and development ("R&D") costs are expensed as incurred and consist of direct and indirect expenditures, including a reasonable allocation of overhead expenses associated with our various R&D programs. Overhead expenses comprise general and administrative support provided to the R&D programs and involve 44 -------------------------------------------------------------------------------- costs associated with support activities such as rent, facility maintenance, utilities, office services, information technology, legal, accounting and human resources. Significant judgment is required in the selection of an appropriate methodology for the allocation of overhead expenses. Our methodology for the allocation of overhead expenses utilizes the composition of our workforce as the basis for our allocation. Specifically, we determine the proportion of our workforce that is dedicated to R&D activities and allocate to R&D expense the equivalent proportion of overhead expenses. We consider this method the most reasonable method of allocation based on the nature of our business and workforce. Changes in the composition of our workforce and the types of support activities are factors that may influence our allocation of overhead expenses.
Costs related to the acquisition of development rights for which no alternative use exists are classified as research and development and expensed as incurred.
Patent application, filing and defense costs are also expensed as incurred.
Income Taxes Income taxes are reported using the asset and liability method, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to: (i) differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and (ii) operating loss and tax credit carryforwards using applicable enacted tax rates. An increase or decrease in these tax rates will increase or decrease the carrying value of future net tax assets resulting in an increase or decrease to net income. Income tax credits, such as investment tax credits, are included as part of the provision for income taxes. Significant estimates are required in determining our provision for income taxes. Some of these estimates are based on interpretations of existing tax laws or regulations. Various internal and external factors may have favorable or unfavorable effects on our future effective tax rate. These factors include, but are not limited to, changes in tax laws, regulations and/or rates, changing interpretations of existing tax laws or regulations, changes in estimates of prior years' items, results of tax audits by tax authorities, future levels of research and development spending, changes in estimates related to repatriation of undistributed earnings of foreign subsidiaries, changes in financial statement presentation related to discontinued operations, and changes in overall levels of pre-tax earnings. The realization of our deferred tax assets is primarily dependent on generating sufficient capital gains and taxable income prior to expiration of any loss carry forward balance. A valuation allowance is provided when it is more likely than not that a deferred tax asset will not be realized. The assessment of whether or not a valuation allowance is required often requires significant judgment including the long-range forecast of future taxable income and the evaluation of tax planning initiatives. Adjustments to the deferred tax valuation allowances are made to earnings in the period when such assessments are made.
We record tax benefits for all years subject to examination based upon management's evaluation of the facts, circumstances and information available at the reporting date. There is inherent uncertainty in quantifying income tax positions. We have recorded tax benefits for those tax positions where it is more likely than not that a tax benefit will be sustained upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where it is not more likely than not that a tax benefit will be sustained, no tax benefit has been recognized in the financial statements. See Note 11 - Income Taxes in Notes to the Consolidated Financial Statements.
Recently Issued and Recently Adopted Accounting Standards See Note 3 - Significant Accounting Policies in Notes to the Consolidated Financial Statements for a discussion of recently adopted and new accounting pronouncements.
45 -------------------------------------------------------------------------------- COMPARISON OF YEARS ENDED DECEMBER 31, 2013, 2012 and 2011 The following table presents our net income (loss) for the years ended December 31, 2013, 2012 and 2011: Year Ended December 31, (In thousands of U.S. dollars, except per share data) 2013 2012 2011 Net (loss) income and comprehensive (loss) income $ (24,871 ) $ 45,698 $ (30,416 ) Basic and diluted net loss per common share $ (0.49 ) $ 0.91 $ (0.61 ) Detailed discussion and analysis of our results of operations are as follows: Expenses Research and Development During the year ended December 31, 2013, research and development ("R&D") expenditures from continuing operations were $18.5 million compared to $24.6 million for the same period in 2012. The $6.1 million (25%) decrease was primarily due to: (i) $4.8 million of savings resulting from our 2012 workforce reduction and lower spending on our synthetic retinoid program QLT091001, and (ii) the $1.2 million impact of the accelerated vesting of certain stock options recorded in 2012 in connection with the election of a new Board of Directors on June 4, 2012.
During the year ended December 31, 2012, R&D expenditures from continuing operations were $24.6 million compared to $23.0 million for the same period in 2011. The $1.6 million (7%) increase was primarily due to the $1.2 million charge discussed above related to the accelerated vesting of certain stock options and higher spending on our synthetic retinoid program QLT091001 in 2012 relative to 2011.
R&D expenditures related to our former Visudyne business and PPDS Technology are presented as discontinued operations on the Consolidated Statements of Operations and Comprehensive (Loss) Income. For additional discussion on these expenditures, refer to the Income from Discontinued Operations, Net of Income Taxes section below and Note 12 - Discontinued Operations and Assets Held for Sale in Notes to the Consolidated Financial Statements for the year ended December 31, 2013.
Total cumulative costs incurred through December 31, 2013 related to QLT091001 were $94.4 million.
For a more detailed description of our significant development programs, refer to the Research and Development and Our Products in Development sections under Item 1 of this Report.
Selling, General and Administrative Expenses For the year ended December 31, 2013, selling, general and administration ("SG&A") expenses were $7.0 million compared to $15.1 million for the same period in 2012. The $8.1 million (54%) decrease was primarily due to: (i) $6.9 million of savings resulting from our 2012 workforce reduction, a decrease in discretionary spending and other restructuring activities; and (ii) higher compensation expense incurred in 2012 related to the $1.2 million impact of the accelerated vesting of certain stock options and directors' deferred stock units in connection with the election of a new Board of Directors on June 4, 2012.
For the year ended December 31, 2012, SG&A expenses were $15.1 million compared to $17.1 million for the same period in 2011. The $2.0 million (11.6%) decrease was primarily due to savings resulting from our 2012 workforce reduction, which were partially offset by the $1.2 million charge noted above related to accelerated vesting of certain stock options and deferred stock units discussed above.
Depreciation During the year ended December 31, 2013, depreciation expense was $1.0 million compared to $1.2 million for the same period in 2012. The $0.2 million (17%) decrease was primarily due to the continuing impact of the 2012 $1.1 million impairment write-down of certain property, plant and equipment related to the restructuring, which was announced in July 2012.
46 -------------------------------------------------------------------------------- During the year ended December 31, 2012, depreciation expense was $1.2 million compared to $1.3 million for the same period in 2011. The $0.1 million (8%) decrease was primarily due to the $1.1 million impairment charge discussed above.
Restructuring charges During the year ended December 31, 2012, we restructured our operations to focus our resources on our clinical development programs related to our synthetic retinoid, QLT091001, for the treatment of certain inherited retinal diseases.
Following the sale of Visudyne to Valeant, we further reduced our workforce to better align the Company's resources with our corporate objectives.
Approximately 180 employees have been affected by the restructuring to date.
Severance and support provisions were made to assist these employees with outplacement. As at December 31, 2013, annualized operating savings specifically related to the workforce reduction is approximately $25.0 million.
Effective December 18, 2013, we entered into a letter agreement with Alexander R. Lussow, the Company's Senior Vice President, Business Development and Commercial Operations, in which we, among other things, agreed to terminate his employment on either March 31, 2014, April 30, 2014 or May 31, 2014, at the Company's discretion. The estimated cost of Mr. Lussow's severance and termination benefits are expected to range between $1.0 million to $1.1 million depending on his actual termination date. As at December 31, 2013, we have recognized $0.1 million of this expected obligation in our restructuring accrual and expense in accordance with ASC No. 420 - Exit or Disposal Cost Obligations.
Based on the terms of Mr. Lussow's current termination arrangement, we expect that his severance and termination benefits will be substantially paid out by the end of the second quarter of 2014. Refer to Note 9 - Restructuring Charges in the Notes to the Consolidated Financial Statements.
During the year ended December 31, 2013, we recorded $2.0 million of restructuring charges, which primarily consisted of $1.7 million of severance and termination benefits, $0.4 million of lease termination costs related to excess office space which was vacated in 2012 and 2013, and $0.2 million of relocation charges related to the downsizing of our office space. These charges were partially offset by a $0.3 million recovery from sales of certain property, plant and equipment that was previously written off in 2012 and/or classified as held for sale.
During the year ended December 31, 2012, we recorded $16.9 million of restructuring charges ($3.1 million of this amount was included in discontinued operations), which primarily consisted of $14.6 million of severance and termination benefits, $1.1 million of property, plant and equipment impairment charges, and $1.3 million of contract termination costs.
Investment and Other Income (Expense) Net Foreign Exchange Losses For the years ended December 31, 2013, 2012 and 2011, net foreign exchange losses represent the impact of foreign exchange fluctuations on our monetary assets and liabilities that are denominated in currencies other than the U.S.
dollar (principally the Canadian dollar). See the Liquidity and Capital Resources: Interest and Foreign Exchange Ratessection below.
Interest Income Interest income was $0.2 million for the years ended December 31, 2013 and 2012.
During the year ended December 31, 2012, interest income decreased by 71% to $0.2 million from $0.7 million in 2011. The decrease was primarily driven by the $0.5 million of interest income earned in 2011 on the mortgage receivable from Discovery Parks Holdings Ltd.
Fair Value Change in Contingent Consideration During the year ended December 31, 2013, we recorded fair value gains on our contingent consideration of $2.9 million, compared to fair value gains of $8.2 million and $10.1 million for the same periods in 2012 and 2011, respectively.
Fair value gains arise from the accretion of our contingent consideration assets, which are 47 -------------------------------------------------------------------------------- measured and recorded as the present value of future expected payments. The year-over-year declines in our fair value gains are primarily driven by the impact of cash collected during the period, which decreases the balance of future expected cash flows owed to us.
Related to the Sale of QLT USA, Inc.
During the year ended December 31, 2013, we received $38.7 million of proceeds and recorded a $4.1 million fair value gain related to the contingent consideration associated with our previous sale of QLT USA. Similarly, during the years ended December 31, 2012 and 2011, we received $37.1 million and $40.7 million of proceeds and recorded $8.4 million and $10.1 million of fair value gains, respectively.
Related to the Sale of Visudyne As a result of the dispute with Valeant described under the Sale of Assets and Discontinued Operations section above, during the year ended December 31, 2013, we recorded a $0.8 million decrease in the fair value of our contingent consideration pertaining to the Laser Earn-Out Payment to reflect the increased uncertainty related to collection risk. In addition to the $0.8 million fair value decrease described above, we also recorded a net $0.5 million decrease in the fair value of our contingent consideration related to a revision in our estimate of potential future net royalties owing. As at December 31, 2013, the $4.0 million estimated fair value of the $20.0 million of aggregate potential contingent payments represents the fair value of the $5.0 million Laser Earn-Out Payment net of $1.0 million of potential collection costs to account for the increased uncertainty related to collection risk. The remaining estimated fair value of the contingent consideration, which relates to estimated future net royalties pursuant to the Novartis Agreement, is currently valued at nil. The estimated $4.0 million is recorded as current accounts receivable on our consolidated balance sheet.
During the year ended December 31, 2012, we recorded $0.2 million of fair value decrease related to the Visudyne contingent consideration.
Income from Discontinued Operations, Net of Income Taxes In accordance with the accounting standard for discontinued operations, the results of operations relating to both our PPDS Technology and Visudyne business have been excluded from continuing operations and reported as discontinued operations for all periods presented.
During the year ended December 31, 2013, income from discontinued operations, net of taxes, was $1.0 million and primarily consisted of a $1.1 million gain derived from the sale of our PPDS Technology. For more information refer to the Sales of Assets and Discontinued Operations section above and Note 12 - Discontinued Operations and Assets Held for Sale in Notes to the Consolidated Financial Statements.
During the year ended December 31, 2012, income from discontinued operations, net of taxes, was $88.0 million compared to $1.0 million reported in 2011. The increase was driven by a pre-tax gain of $101.4 million on the divestment of our Visudyne business during the third quarter of 2012. See Note 12 - Discontinued Operations and Assets Held for Sale in Notes to the Consolidated Financial Statements.
Income Taxes During the year ended December 31, 2013, the provision for income taxes related to continuing operations was $0.6 million. The provision primarily relates to the current period gain on the fair value change of our Eligard related contingent consideration. In addition, the provision also reflects our position of having insufficient evidence to support current or future realization of the tax benefits associated with our development expenditures.
During the year ended December 31, 2012, we recorded a net income tax recovery from continuing operations of $3.9 million. The recovery primarily related to the recognition of the tax benefit of our operating losses from continuing operations. As a result of the sale of Visudyne to Valeant, we benefited from a portion of our operating losses from continuing operations.
48 -------------------------------------------------------------------------------- During the year ended December 31, 2011, the provision for income taxes from continuing operations was $1.2 million. The provision primarily relates to the drawdown of the tax asset associated with the gain on the fair value change of the contingent consideration and reflects our position of having insufficient evidence to support current or future realization of the tax benefits associated with our development expenditures at that time.
During the year ended December 31, 2013, the provision for income taxes related to discontinued operations was $0.2 million. The provision primarily relates to the drawdown of a prepaid tax asset that was recorded in a prior year in connection with the intercompany transfer of certain intellectual property and the subsequent sale of such technology to Mati in April 2013. The provision also reflects our position of having insufficient evidence to support current or future realization of the tax benefits associated with expenditures related to our discontinued operations.
During the year ended December 31, 2012, the provision for income taxes related to discontinued operations was $5.8 million. The provision primarily relates to the recognition of the tax cost of utilizing the tax shield associated with our operating losses realized from continuing operations. The provision also reflected that substantially all of the remaining balance of the tax impact of the gain on sale from discontinued operations was offset by tax basis and other tax attributes (e.g. loss carryforwards), which previously had a valuation allowance.
During the year ended December 31, 2011, the provision for income taxes related to discontinued operations was $1.6 million. The provision primarily relates to income taxes associated with our income allocable to our activities in the U.S., as well as the reversal of a prepaid tax asset set up in 2010 in connection with certain profits on intercompany sales of inventory that had not been sold to third parties at that time.
As at December 31, 2013 and 2012, the respective net deferred tax assets of $0.3 million and $1.0 million were largely due to contingent consideration, and other temporary differences against which a valuation allowance was not applied.
As at December 31, 2013 and 2012, we had a full valuation allowance applied against specific tax assets. The valuation allowance is reviewed periodically and if management's assessment of the "more likely than not" criterion for accounting purposes changes, the valuation allowance is adjusted accordingly.
See Note 11 - Income Taxes in Notes to the Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES General As at December 31, 2013, our cash resources, working capital, cash from divestitures, cash collected from contingent consideration, and other available financing resources are sufficient to service current product research and development needs, operating requirements, liability requirements, milestone payments, and restructuring and change in control obligations.
However, factors that may affect our future capital availability or requirements may include: returns of capital to shareholders, including future share repurchases; the status of competitors and their intellectual property rights; levels of future sales of Eligard and our receipt of contingent consideration under the QLT USA stock purchase agreement with Tolmar; levels of future sales of Visudyne and receipt of contingent consideration under the Valeant Agreement; the progress of our R&D programs, including preclinical and clinical testing; the timing and cost of obtaining regulatory approvals; the levels of resources that we devote to the development of manufacturing and other support capabilities; technological advances; the cost of filing, prosecuting and enforcing our patent claims and other intellectual property rights; pre-launch costs related to commercializing our products in development; acquisition and licensing activities; milestone payments and receipts; our ability to establish collaborative arrangements with other organizations; and the pursuit of future financial and/or strategic alternatives.
There is no guarantee that our future liquidity and capital resources will be sufficient to service our operating needs and financial obligations. In this event, our business could be materially and adversely affected and the Company would be required to seek other financing alternatives.
49-------------------------------------------------------------------------------- Sources and Uses of Cash We finance operations, product development and capital expenditures primarily through existing cash, sales of assets and contingent consideration received.
For the year ended December 31, 2013, we used $25.8 million of cash in operations as compared to $41.6 million for the same period in 2012. The $15.8 million positive cash flow variance is primarily attributable to: • A positive operating cash flow variance from lower operational spending of $37.1 million associated with our 2012 restructuring initiatives; • A positive operating cash flow variance from lower spending on restructuring costs of $11.1 million; • A positive operating cash flow variance from higher tax recoveries of $1.0 million; • A positive operating cash flow variance from other income items of $0.6 million; • A negative operating cash flow variance from lower cash receipts from previous product sales and royalties of $29.9 million; and • A negative operating cash flow variance related to the fair value change in contingent consideration of $4.1 million.
For the year ended December 31, 2012, we used $41.6 million of cash in operations as compared to $16.6 million for the same period in 2011. The $25.0 million negative cash flow variance is primarily attributable to: • A negative cash flow variance from restructuring costs of $14.9 million; • A negative operating cash flow variance from lower cash receipts from product sales and royalties of $11.0 million; • A negative operating cash flow variance from proceeds related to the fair value change in contingent consideration of $1.9 million; • A negative operating cash flow variance from lower net tax recoveries of $1.6 million; • A negative operating cash flow variance from lower other income of $1.6 million; and • A positive operating cash flow variance from lower operating and inventory related expenditures of $6.0 million.
During the year ended December 31, 2013, cash flows provided by investing activities consisted of $34.6 million of contingent consideration received in connection with our previous sale of QLT USA, Inc. and $8.5 million of proceeds from the sale of discontinued operations, which includes: (i) $7.5 million of proceeds released from escrow as described above; (ii) $0.8 million of proceeds related to the sale of our PPDS Technology; and (iii) $0.2 million of proceeds from the sale of certain assets and property, plant and equipment, that was previously designated as held for sale. These cash inflows were partially offset by $0.2 million of capital expenditures.
During the year ended December 31, 2012, cash flows provided by investing activities consisted of $101.5 million of net proceeds from the sale of Visudyne; $28.9 million of contingent consideration collected; $5.9 million of proceeds from collection of the mortgage receivable; $0.5 million of proceeds related to the 90-day option granted to Mati to acquire assets related to our PPDS Technology; and $0.3 million of proceeds related to the out-license and sale of certain non-core assets. These cash inflows were partially offset by $0.9 million of capital expenditures.
During the year ended December 31, 2013, cash flows used in financing activities included the $200.0 million Cash Distribution to shareholders and $14.1 million of cash used to repurchase common shares, including repurchase costs. These cash outflows were partially offset by $8.3 million of cash received for the issuance of common shares related to the exercise of stock options.
50 -------------------------------------------------------------------------------- During the year ended December 31, 2012, cash flows provided by financing activities consisted of $20.4 million received for the issuance of common shares related to the exercise of stock options, offset by common shares repurchased for $13.1 million.
Interest and Foreign Exchange Rates We are exposed to market risk related to changes in interest and foreign currency exchange rates, each of which could adversely affect the value of our current assets and liabilities. At December 31, 2013, we had $118.5 million in cash and cash equivalents and our cash equivalents had an average remaining maturity of approximately 7.5 days. If market interest rates were to increase immediately and uniformly by one hundred basis points from levels at December 31, 2013, the fair value of the cash equivalents would decline by an immaterial amount due to the short remaining maturity period.
The functional currency of QLT Inc. and its U.S. subsidiaries is the U.S.
dollar, therefore our U.S. dollar-denominated cash and cash equivalents holdings do not result in foreign currency gains or losses in operations. To the extent that QLT Inc. holds a portion of its monetary assets and liabilities in Canadian dollars, we are subject to translation gains and losses. These translation gains and losses are included in operations for the period.
At December 31, 2013 and 2012, we had no outstanding forward foreign currency contracts.
Contractual Obligations In the normal course of business, we enter into purchase commitments related to daily operations. In addition, we have entered into operating lease agreements related to office space, vehicles and office equipment. The minimum annual commitments related to these agreements are as follows: (in thousands of U.S. dollars) Payments due by period Less than More than Contractual Obligations(1) Total 1 year 1-3 years 3-5 years 5 years Operating Leases(2) $ 1,062 $ 632 430 $ - $ - Purchase Obligations(3) 7,355 7,205 150 - - Milestone Obligations(4) 1,000 1,000 - - - Total $ 9,417 $ 8,837 $ 580 $ - $ - (1) At December 31, 2013, we had approximately $1.8 million of long-term liabilities associated with uncertain tax positions. At this time, we are unable to make a reasonably reliable estimate of the timing of future payments, if any, due to uncertainties in the timing of future outcomes of tax audits that may arise. As a result, uncertain tax liabilities are not included in the table above.
(2) Operating leases comprise our long-term lease of office space and photocopiers.
(3) In accordance with U.S. GAAP, these purchase obligations relate to expected future expenditures that are not reflected on our Consolidated Balance Sheet as at December 31, 2013. Total purchase obligations of $7.4 million consist of $4.2 million in ongoing research contracts with third-party organizations and $3.2 million in other outstanding purchase commitments related to the normal course of business. Although all of our material research contracts with third-party organizations are cancelable, we do not intend to cancel such contracts. These amounts reflect commitments based on existing contracts and do not reflect any future modifications to, or terminations of, existing contracts or anticipated or potential new contracts.
(4) We have also committed to make potential future milestone payments to certain third parties as part of our licensing, development, and purchase agreements. Payments under these arrangements generally become due and payable upon achievement of certain developmental, regulatory or commercial milestones. Where the achievement of these milestones is probable, we have included them in the table above. For more information refer to Note 15 (b) - Contingencies, Commitments and Guarantees - Milestone and Royalty Obligations under the Notes to the Consolidated Financial Statements for the year ended December 31, 2013 and Item 1. Business - Our Products in Development, QLT091001- Synthetic Retinoid Program of this Report on Form 10-K.
51 -------------------------------------------------------------------------------- Off-Balance Sheet Arrangements In connection with the sale of assets and businesses, we provide indemnities with respect to certain matters, including product liability, patent infringement, contractual breaches and misrepresentations, and we provide other indemnities to third parties under the clinical trial, license, service, manufacturing, supply, distribution and other agreements that we enter into in the normal course of our business. If the indemnified party were to make a successful claim pursuant to the terms of the indemnification, we would be required to reimburse the loss. These indemnities are generally subject to threshold amounts, specified claims periods and other restrictions and limitations. As at December 31, 2013, no amounts have been accrued in connection with such indemnities.
Except as described above and the contractual arrangements described in the Contractual Obligations section above, we do not have any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
CERTAIN CANADIAN AND U.S. FEDERAL INCOME TAX INFORMATION FOR U.S. RESIDENTS The following is a summary of certain Canadian and U.S. federal income tax considerations applicable to holders of common shares of the Company. These tax considerations are stated in brief and general terms and are based on Canadian and U.S. law currently in effect. There are other potentially significant Canadian and U.S. federal income tax considerations and provincial, state and local income tax considerations with respect to ownership and disposition of the common shares which are not discussed herein. The tax considerations relative to ownership and disposition of the common shares may vary from shareholder to shareholder depending on the shareholder's particular status. Accordingly, shareholders and prospective shareholders are encouraged to consult with their tax advisors regarding tax considerations which may apply to the particular situation.
Canadian Federal Tax Information The following is a general summary of the principal Canadian federal income tax considerations generally applicable to a holder of common shares of the Company who, at all relevant times, for purposes of the Income Tax Act (Canada) (the "Canadian Tax Act") (i) is not, or is not deemed to be, a resident of Canada, (ii) holds the common shares as capital property, (iii) deals at arm's length with, and is not affiliated with, the Company and (iv) does not and will not use or hold, and is not and will not be deemed to use or hold, common shares of the Company in connection with carrying on a business in Canada (a "Non-Resident Holder"). Special rules, which are not discussed in this summary, may apply to a Non-Resident Holder that is an insurer carrying on business in Canada and elsewhere. Common shares of the Company will generally be considered to be capital property to a holder thereof, unless the shares are held in the course of carrying on a business or were acquired in a transaction considered to be an adventure in the nature of trade.
Dividends paid, deemed to be paid, or credited on the common shares held by Non-Resident Holders will generally be subject to Canadian withholding tax at the rate of 25% of the gross amount of the dividend unless the rate is reduced by an applicable income tax convention or treaty. The Canada-U.S. Income Tax Convention (1980) (the "Convention") provides that the withholding tax rate on dividends paid on the common shares to U.S. residents who qualify for the benefit of the Convention will generally be reduced to 15% of the gross amount of the dividend.
A Non-Resident Holder will generally not be subject to Canadian income tax in respect of any gain realized on the disposition of common shares unless the common shares constitute "taxable Canadian property" to such Non-Resident Holder and such Non-Resident Holder is not entitled to relief under an applicable income tax treaty or convention. Generally, provided the common shares are then listed on a designated stock exchange for purposes of the Canadian Tax Act (which includes the TSX and the NASDAQ), the common shares will not be "taxable Canadian property" to a Non-Resident Holder unless, at any particular time during the 60-month period immediately preceding the disposition (i) 25% or more of the issued shares of any class or series of the capital stock of the Company were owned by such Non-Resident Holder, by persons with whom the Non-Resident Holder did not deal at arm's length, or any combination thereof and (ii) the shares derived more than 50% of their fair market value directly or indirectly from one or any combination of real or immovable property situated 52-------------------------------------------------------------------------------- in Canada, Canadian resource properties or timber resource properties (as defined in the Canadian Tax Act), or options in respect of, or interests or rights in any of the foregoing. A gain realized upon the disposition of the common shares by a U.S. resident who qualifies for the benefits of the Convention that is otherwise subject to Canadian tax may be exempt from Canadian tax under the Convention.
Where the common shares are disposed of by way of an acquisition of such common shares by the Company, other than a purchase in the open market in the manner in which common shares normally would be purchased by any member of the public in the open market, the amount paid by the Company in excess of the paid-up capital of such common shares will be treated as a dividend and will be subject to non-resident withholding tax as described above.
U.S. Federal Income Tax Information Special U.S. federal income tax rules apply to "U.S. Holders" (as defined below) of stock of a "passive foreign investment company" (a "PFIC"). As previously disclosed, the Company believes, but cannot offer any assurance, that it was classified as a PFIC for one or more taxable years prior to 2000, and that it was not a PFIC during any of the taxable years from the taxable year ended December 31, 2000 through the taxable year ended December 31, 2007. The Company further believes that it was a PFIC for the taxable years ended December 31, 2008 through 2013, which significantly impacts the U.S. federal income tax consequences to U.S. Holders. The Company is uncertain regarding its potential PFIC status for the taxable year ending December 31, 2014. The Company's actual PFIC status for a given taxable year will not be determinable until the close of such year and, accordingly, no assurances can be given regarding the Company's PFIC status in 2014 or any future year. See further discussion of the PFIC rules below. In addition, the following assumes that the common shares are held as a capital asset within the meaning of Section 1221 of the Internal Revenue Code of 1986, as amended (the "Code").
This summary is of a general nature only and is not intended for non-U.S. Holders. Furthermore, it is not intended to constitute, and should not be construed to constitute, legal or tax advice to any particular U.S. Holder, and it does not address U.S. federal income tax considerations that may be relevant to U.S. Holders that are subject to special treatment under U.S. federal income tax law. U.S. Holders are urged to consult their own tax advisors as to the tax consequences in their particular circumstances.
U.S. Holders A "U.S. Holder" is a holder of the Company's common shares that is (i) an individual who is a citizen or resident of the United States for U.S. federal income tax purposes; (ii) a corporation (or other entity taxed as a corporation for U.S. federal income tax purposes) created or organized under the laws of the United States, any U.S. state or the District of Columbia; (iii) an estate the income of which is subject to U.S. federal income taxation regardless of the income's source; or (iv) a trust (a) if a U.S. court is able to exercise primary supervision over the trust's administration and one or more U.S. persons, as defined under Section 7701(a)(30) of the Code, have authority to control all of the trust's substantial decisions; or (b) that was in existence on August 20, 1996, was treated as a U.S. person under the Code on the previous day and has a valid election in effect under applicable U.S. Treasury regulations to be treated as a U.S. person.
Sale or Other Disposition of Common Shares Subject to different treatment pursuant to the PFIC rules discussed below, if a U.S. Holder engages in a sale, exchange or other taxable disposition of such U.S. Holder's common shares, (i) such U.S. Holder will recognize gain or loss equal to the difference between the amount realized by such U.S. Holder and such U.S. Holder's adjusted tax basis in the common shares, (ii) any such gain or loss will be capital gain or loss, and (iii) such capital gain or loss will be long-term capital gain or loss if the holding period of the common shares exceeds one year as of the date of the sale. Such gain generally is treated as U.S. source gain for U.S. foreign tax credit limitation purposes.
If the Company purchases common shares from a U.S. Holder, such transaction will be treated as a taxable sale or exchange of the common shares by the U.S. Holder if the transaction meets certain conditions under U.S. federal income tax rules, or otherwise will be treated as a distribution by the Company in respect of the U.S. Holder's common shares, as described below.
53-------------------------------------------------------------------------------- Distributions on Common Shares Subject to different treatment pursuant to the PFIC rules discussed below, a distribution with respect to our common shares generally will be treated as a dividend, taxable as ordinary income, to the extent of the Company's current or accumulated earnings and profits, as determined under U.S. federal income tax principles. In general, to the extent that the amount of the distribution exceeds the Company's current and accumulated earnings and profits, the excess first will be treated as a tax-free return of capital that will reduce the holder's tax basis in the holder's common shares, and to the extent of any remaining portion in excess of such tax basis, the excess will be taxable as capital gain. Any such capital gain will be long-term capital gain if the U.S.
Holder has held the common shares for more than one year at the time of the distribution. However, under U.S. Treasury regulations regarding the treatment of PFICs, a purchase of common shares from a U.S. Holder by the Company that does not qualify as a "sale or exchange" under U.S. federal income tax rules, and hence is treated as a distribution, is in fact treated as a distribution in full for PFIC purposes regardless of whether there are any earnings and profits.
A dividend received by a corporate U.S. Holder generally will not be eligible for a dividends-received deduction. In addition, a dividend received by an individual U.S. Holder will not qualify for the 15% reduced maximum rate if the Company is a PFIC in the year in which the dividend is paid or in the preceding year.
Dividends will constitute foreign source income for foreign tax credit limitation purposes. The limitation on foreign taxes eligible for credit is calculated separately with respect to specific classes of income. For this purpose, dividends distributed by the Company with respect to our common shares will constitute "passive category income" or, in the case of certain U.S.
Holders, "general category income." Passive Foreign Investment Company A non-U.S. corporation generally will be classified as a PFIC for U.S. federal income tax purposes in any taxable year in which, after applying relevant look-through rules with respect to the income and assets of subsidiaries, either 75% or more of its gross income is "passive income" (the income test) or 50% or more of the average value of its assets consists of assets that produce, or are held for the production of, passive income (the asset test). For this purpose, passive income generally includes, among other things, dividends, interest, certain rents and royalties and gains from the disposition of passive assets.
The Company believes that it may be deemed a PFIC for 2008 through 2013. Please be aware that the Company's status as a PFIC can have significant adverse tax consequences for U.S. Holders.
A U.S. Holder that holds common shares while the Company is a PFIC may be subject to increased tax liability upon the sale, exchange or other disposition of the common shares or upon the receipt of certain distributions, regardless of whether the Company is a PFIC in the year in which such disposition or distribution occurs. These adverse tax consequences will not apply, however, if (i) a U.S. Holder timely filed and maintained (and in certain cases, continues to maintain), or timely files and maintains, as the case may be, a qualified electing fund ("QEF") election to be taxed annually on the U.S. Holder's pro rata portion of the Company's earnings and profits, (ii) the U.S. Holder timely made or makes, as the case may be, a mark-to-market election as described below, or (iii) a U.S. Holder is eligible to make a "purging" election and timely does so, as described below.
The adverse tax consequences include: (a) "Excess distributions" by the Company are subject to the following special rules. An excess distribution generally is the excess of the amount a PFIC distributes to a shareholder during a taxable year over 125% of the average amount it distributed to the shareholder during the three preceding taxable years or, if shorter, the part of the shareholder's holding period before the taxable year. Distributions with respect to the common shares made by the Company during the taxable year to a U.S. Holder that are excess distributions must be allocated ratably to each day of the U.S. Holder's holding period. The amounts allocated to the current taxable year and to taxable years prior to the first year in which the Company was classified as a PFIC are included as ordinary income in a U.S. Holder's gross income for that year. The amount allocated to each other prior taxable year is taxed 54 -------------------------------------------------------------------------------- as ordinary income at the highest tax rate in effect for the U.S. Holder in that prior year (without offset by any net operating loss for such year) and the tax is subject to an interest charge at the rate applicable to deficiencies in income taxes (the "special interest charge").
(b) The entire amount of any gain realized upon the sale or other disposition of the common shares will be treated as an excess distribution made in the year of sale or other disposition and as a consequence will be treated as ordinary income and, to the extent allocated to years prior to the year of sale or disposition, will be subject to the special interest charge described above.
QEF Election. A U.S. Holder of stock in a PFIC may make a QEF election with respect to such PFIC to elect out of the tax treatment discussed above.
Generally, a QEF election, on U.S. Internal Revenue Service ("IRS") Form 8621, should be made with the filing of a U.S. Holder's U.S. federal income tax return for the first taxable year for which both (i) the U.S. Holder holds common shares of the Company, and (ii) the Company was a PFIC. A U.S. Holder that timely makes a valid QEF election with respect to a PFIC will generally include in gross income for a taxable year (i) as ordinary income, such holder's pro rata share of the corporation's ordinary earnings for the taxable year, and (ii) as long-term capital gain, such holder's pro rata share of the corporation's net capital gain for the taxable year. However, the QEF election is available only if such PFIC provides such U.S. Holder with certain information regarding its earnings and profits as required under applicable U.S.
Treasury regulations. The Company will provide, upon request, all information and documentation that a U.S. Holder making a QEF election is required to obtain for U.S. federal income tax purposes (e.g., the U.S. Holder's pro rata share of ordinary income and net capital gain, and a "PFIC Annual Information Statement" as described in applicable U.S. Treasury regulations, which will be made available on the Company's website).
Deemed Sale Election. If the Company is a PFIC for any year during which a U.S.
Holder holds common shares, but the Company ceases in a subsequent year to be a PFIC (which could occur, for example, if the Company were a PFIC for 2013 but is not a PFIC for 2014), then a U.S. Holder can make a "purging" election, in the form of a deemed sale election, for such subsequent year in order to avoid the adverse PFIC tax treatment described above that would otherwise continue to apply because of the Company having previously been a PFIC. If such election is timely made, the U.S. Holder would be deemed to have sold the common shares held by the holder at their fair market value, and any gain from such deemed sale would be taxed as an excess distribution (as described above). The basis of the common shares would be increased by the gain recognized, and a new holding period would begin for the common shares for purposes of the PFIC rules. The U.S. Holder would not recognize any loss incurred on the deemed sale, and such a loss would not result in a reduction in basis of the common shares. After the deemed sale election, the U.S. Holder's common shares with respect to which the deemed sale election was made would not be treated as shares in a PFIC, unless the Company subsequently becomes a PFIC. A U.S. Holder may also be able to make a deemed sale election with respect to the Company's subsidiaries that are PFICs, if any. The rules regarding deemed sale elections are very complex. U.S.
Holders are strongly urged to consult their tax advisors about the deemed sale election with regard to the Company and any subsidiaries.
Mark-to-Market Election. Alternatively, a U.S. Holder of "marketable stock" (as defined below) in a PFIC may make a mark-to-market election for such stock to elect out of the adverse PFIC tax treatment discussed above. If a U.S. Holder makes a mark-to-market election for shares of marketable stock, the holder will include in income each year an amount equal to the excess, if any, of the fair market value of the shares as of the close of the holder's taxable year over the holder's adjusted basis in such shares. A U.S. Holder is allowed a deduction for the excess, if any, of the adjusted basis of the shares over their fair market value as of the close of the taxable year. However, deductions are allowable only to the extent of any net mark-to-market gains on the shares included in the holder's income for prior taxable years. Amounts included in a U.S. Holder's income under a mark-to-market election, as well as gain on the actual sale or other disposition of the shares, are treated as ordinary income. Ordinary loss treatment also applies to the deductible portion of any mark-to-market loss on the shares, as well as to any loss realized on the actual sale or disposition of the shares, to the extent that the amount of such loss does not exceed the net mark-to-market gains previously included for such shares. A U.S. Holder's basis in the shares will be adjusted to reflect any such income or loss amounts.
However, the special interest charge and related adverse tax consequences described above for non-electing holders may continue to apply on a limited basis if the U.S. Holder makes the mark-to-market election after such holder's holding period for the shares has begun.
55 -------------------------------------------------------------------------------- The mark-to-market election is available only for "marketable stock," which is stock that is traded in other than de minimis quantities on at least 15 days during each calendar quarter on a qualified exchange or other market, as defined in applicable U.S. Treasury regulations. The Company's common shares are listed on the TSX and quoted on NASDAQ, each of which constitutes a "qualified exchange or other market" under applicable U.S. Treasury regulations. U.S. Holders of common shares are urged to consult their tax advisors as to whether the common shares would qualify for the mark-to-market election.
Subsidiary PFICs. To the extent any of the Company's subsidiaries is also a PFIC, a U.S. Holder will also be deemed to own shares in such lower-tier PFIC and could incur a liability for the deferred tax and special interest charge described above if either (i) the Company receives a distribution from, or disposes of all or part of its interest in, the lower-tier PFIC, or (ii) the U.S. Holder disposes of all or part of such holder's common shares. In addition, the mark-to-market election cannot be made for a subsidiary of a PFIC if the stock of such subsidiary is not itself marketable stock.
Recent Legislation. On December 30, 2013, the U.S. Treasury and IRS issued final regulations (2013 Regulations) defining PFIC shareholders and their reporting requirements. The 2013 Regulations implement the PFIC reporting requirements added under legislation enacted in 2010, under which, unless otherwise provided by the U.S. Treasury, each U.S. Holder of a PFIC is required to file an annual report on IRS Form 8621 containing such information as the U.S. Treasury may require. As these regulations are effective as of December 30, 2013, each U.S.
Holder must file IRS Form 8621 with their 2013 income tax returns with respect to their holding in the Company. However, the reporting requirements for holding the Company shares in 2011 and 2012, which were previously suspended, now do not apply. The 2013 Regulations also provide certain exceptions to the reporting requirements. U.S. Holders should consult their tax advisors regarding any reporting requirements that may apply to them and the effect, if any, of this legislation on their ownership and disposition of our common shares.
THE APPLICABILITY AND CONSEQUENCES OF THE PFIC RULES ARE EXCEEDINGLY COMPLEX. IN ADDITION, THE FOREGOING SUMMARY DOES NOT ADDRESS ALL OF THE POTENTIAL U.S. FEDERAL INCOME TAX CONSEQUENCES WITH RESPECT TO PFIC STATUS THAT MAY BE RELEVANT TO A PARTICULAR INVESTOR IN LIGHT OF SUCH INVESTOR'S PARTICULAR CIRCUMSTANCES OR THAT MAY BE RELEVANT TO INVESTORS THAT ARE SUBJECT TO SPECIAL TREATMENT UNDER U.S. FEDERAL INCOME TAX LAW. ACCORDINGLY, INVESTORS ARE STRONGLY URGED TO CONSULT THEIR TAX ADVISORS REGARDING THE APPLICATION OF THE PFIC RULES TO THEM AND THE ADVISABILITY OF MAKING ANY OF THE ELECTIONS DESCRIBED ABOVE.
Outstanding Share Data On April 25, 2013, the Company's board of directors amended and restated the QLT 2000 Incentive Stock Plan (the "Plan") to increase the number of shares of the Company's common stock, without par value, available for grant under the Plan from 7,800,000 to 11,800,000 and to make certain other amendments to the Plan, including to permit the granting of restricted stock units ("RSU's") under the Plan. The amendment and restatement of the Plan was subject to shareholder approval, which was obtained on June 14, 2013. On July 29, 2013, the Company filed a registration statement to register the issuance of up to an additional 4,000,000 common shares that may be issued under the Plan as a result of the amendment to the Plan.
As of February 24, 2014, there were 51,081,878 common shares issued and outstanding, which totaled $466.2 million in share capital. As of February 24, 2014, we had 1,407,529 stock options outstanding of which 341,229 were exercisable at a weighted average exercise price of CAD $5.32 per share. Each stock option is exercisable for one common share. As of February 24, 2014, we had 42,000 RSU's outstanding none of which are vested. Upon vesting, each RSU represents the right to receive one common share of the Company. As of February 24, 2014, we had 154,000 deferred stock units outstanding of which 55,611 are vested. The cash value of the deferred stock units outstanding as at February 24, 2014 is $1.1 million.
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